Des Hennelly, FCII Strategy, Planning

1
Des Hennelly, FCIIStrategy, Planning Analysis
ExecutiveRSA Insurance Ireland
THE UNDERWRITING CYCLE
12 November 2009
Disclaimer The Insurance Institute of Ireland
does not endorse or approve the content of any
third party.
2
CONTENTS

• Introduction
• Prices and COR
• Prices, COR and Capital
• Where are we now?
• Conclusion

3
WHAT? WHY?
What is the insurance underwriting cycle?
Alternating periods of increasing insurance
prices (hard market) and decreasing insurance
prices (soft market)
Why is there an insurance underwriting cycle?

• Large time lag between sale of the product and
  cost of production being known
• Creates space for wide range of assumptions
• Incorrect or over-optimistic assumptions
• Investment returns contribute the majority of
  general insurer earnings
• UW sins covered up by investment returns/profit
• Rapid and large changes in the supply of
  insurance (capacity/capital)

4
COR, INVESTMENT RETURNS AND ROC
NORMALISED INSURANCE CO LTD
Net Premium Claims Expenses Commission 1.
Underwriting Profit (COR 98)
1,000.00 980.00 20.00
5
COR, INVESTMENT RETURNS AND ROC
NORMALISED INSURANCE CO LTD
Net Premium Claims Expenses Commission 1.
Underwriting Profit (COR 98)
1,000.00 980.00 20.00
Investment Return On capital (assumed to be 50
of premium 500) 50 in equities at 5
return 50 in fixed interest securities at
3 return
12.50 7.50
On claims and premium reserves (assumed to be
200 of premium 2,000) 20 in working
capital at 0 return 80 in fixed interest
securities at 3 return 2. Total investment
return
0.00 48.00 68.00
6
COR, INVESTMENT RETURNS AND ROC
NORMALISED INSURANCE CO LTD
Net Premium Claims Expenses Commission 1.
Underwriting Profit (COR 98)
1,000.00 980.00 20.00
Investment Return On capital (assumed to be 50
of premium 500) 50 in equities at 5
return 50 in fixed interest securities at
3 return
12.50 7.50
On claims and premium reserves (assumed to be
200 of premium 2,000) 20 in working
capital at 0 return 80 in fixed interest
securities at 3 return 2. Total investment
return
0.00 48.00 68.00
3. Operating Profit (1 2) Taxation
(12.5) Post-tax Operating Profit
88.00 -11.00 77.00
7
COR, INVESTMENT RETURNS AND ROC
NORMALISED INSURANCE CO LTD
Net Premium Claims Expenses Commission 1.
Underwriting Profit (COR 98)
1,000.00 980.00 20.00
Investment Return On capital (assumed to be 50
of premium 500) 50 in equities at 5
return 50 in fixed interest securities at
3 return
12.50 7.50
On claims and premium reserves (assumed to be
200 of premium 2,000) 20 in working
capital at 0 return 80 in fixed interest
securities at 3 return 2. Total investment
return
0.00 48.00 68.00
3. Operating Profit (1 2) Taxation
(12.5) Post-tax Operating Profit
88.00 -11.00 77.00
77.00 500.00
Post-tax Operating profit Capital

8
COR, INVESTMENT RETURNS AND ROC
NORMALISED INSURANCE CO LTD
Net Premium Claims Expenses Commission 1.
Underwriting Profit (COR 98)
1,000.00 980.00 20.00
Investment Return On capital (assumed to be 50
of premium 500) 50 in equities at 5
return 50 in fixed interest securities at
3 return
12.50 7.50
On claims and premium reserves (assumed to be
200 of premium 2,000) 20 in working
capital at 0 return 80 in fixed interest
securities at 3 return 2. Total investment
return
0.00 48.00 68.00
3. Operating Profit (1 2) Taxation
(12.5) Post-tax Operating Profit
88.00 -11.00 77.00
77.00 500.00
Post-tax Operating profit Capital

Return on capital
15
9
INSURANCE CYCLE
Forces increasing prices
Inflection point
Forces reducing prices
00
96
01
02
03
04
05
06
07
08
09
10
97
98
99
UW profits
Penalty points introduced
Escalating claims inflation
PIAB established
Reserve strengthening for 1990s claims
Recovering equity markets
Interest rates hit 40 year lows
Injury claims frequencies costs reduce
High interest rates
Capital depletion
Large UW and Investment losses
Prolonged equity bull market
Capital depletion
Litigation reform
Aggressive market share competition
Sept 11 WTC
Deepening equity bear market
Under-reserving of bodily injury claims
Aggressive market share competition
Recession impacts
New motorways / dual-carriageways
Failure of Independent Ins
Weather events
Penalty point enforcement
Equities bear market
Rising UW losses
Emergence of equity bear market
Interest rates close to nil
Large UW losses
UW losses
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THERE IS SOMETHING DIFFERENT ABOUT INSURANCE -
MOTOR AND HOME PRICES
Commentary
Soft
Soft
Hard
Hard

• In an inflationary decade insurance prices fell
  dramatically
• In 2008, Motor car insurance prices reached pre
  1998 levels
• In 2008, Household premium bottomed at 2001
  levels
• In 2009, in the first deflationary year in many
  decades
• Motor car premiums are up 15
• Household premiums are up 25
• Yes, we are different

Source CSO
11
CONTENTS

• Introduction
• Prices and COR
• Prices, COR and Capital
• Where are we now?
• Conclusion

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COMBINED OPERATING RATIO
Commentary
Soft
Soft
Soft
Hard
Hard
Hard

• Soft market rising COR
• Usually!
• 2003 2007 was different
• Soft market reducing COR
• Dramatic reversal in COR in 2008
• Previous 2 soft market forced 120 peak CORs
• Are we on the way to 120 COR again?

Source Financial Regulator
13
COR v CY COR
Commentary

• Strong profits in 2003-2007 driven by prior year
  claims releases
• Prior year impact on COR
• 2003 3
• 2004 7
• 2005 11
• 2006 17
• 2007 25
• 2008 18
• Trouble brewing since end 2006
• Large UW losses on CY business

Source Financial Regulator
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WHY WAS 2003 - 2007 DIFFERENT?STRUCTURAL AS WELL
AS CYCLICAL CHANGES
Inflection point
Forces reducing prices
02
03
04
05
06
07
08
UW profits
Penalty points introduced
Litigation reform
PIAB established
New motorways / dual-carriageways
Penalty point enforcement
U/W losses
14
15
WHY WAS 2003 - 2007 DIFFERENT?ONE-OFF STRUCTURAL
EVENT
New Claims Notified All Classes
Commentary
000s

• Sustained improvement in road safety
• Penalty points
• Motorways and dual carriage-ways
• Enforcement
• Cultural behavioural changes
• Other beneficial developments
• Punt to Euro 11
• Injuries Board
• Litigation reform
• Industry anti-fraud campaigns
• Clear economic basis for price reductions up to
  2006

Structural Event
Source IIF
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WHY WAS 2003 - 2007 DIFFERENT?EXCEPTIONAL CLAIMS
DEVELOPMENTS
Commentary
Soft
Soft
Hard
Hard

• More claims reserves than was required
• Claims reserves funded premium reductions
  2003-2008
• Claims O/S Claims Paid ratio returning towards
  equilibrium by end 2008

MOTOR LIABILITY CLAIMS O/S CLAIMS PAID
525
501
468
492
427
351
322
309
347
297
291
Source Financial Regulator
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CONTENTS

• Introduction
• Prices and COR
• Prices, COR and Capital
• Where are we now?
• Conclusion

18
COR AND CAPITAL
Commentary
Soft
Hard
Soft
Hard

• Capital in the market increased 200 in 6 years
  to 2006
• Driven by exceptional CORs
• Despite large dividend payments
• Funded constantly reducing prices
• Capacity reduced sharply by end 2008
• 2007 dividend equalled 33 of industry capital
• Large losses in 2008 depleted capital further
• Capital to NWP
• 2006 86
• 58
• ?

m
Based on six key market insurers
Source Financial Regulator
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RETURN ON CAPITAL
Commentary
Soft
Soft
Hard
Hard

• Exceptional ROC in 2003-2007
• Structural benefits generated large UW profits
• Solid investment contribution also in this period
• Collapse into negative ROC in 2008
• UW losses
• Large investment losses
• 2009 ROC may also be negative
• Large UW losses

Based on six key market insurers
Source Financial Regulator
20
CONTENTS

• Introduction
• Prices and COR
• Prices, COR and Capital
• Where are we now?
• Conclusion

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INTERIM 2009 PREMIUM GROWTH
Commentary

• Reduced housing completions
• Reduced new car sales
• Less and smaller businesses
• Consumers reducing cover

IIF -7.1
Source Insurer Interim Results Statements and IIF
22
FIRST HALF 2009 COR
Commentary

• CORs generally higher
• CY CORs heading sharply higher
• 120 for 2009
• PY year claims releases running down
• Recovering equity markets but interest rates near
  zero
• Another industry loss and further capital
  impairment likely in 2009

23
CONTENTS

• Introduction
• Prices and COR
• Prices, COR and Capital
• Where are we now?
• Conclusion

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HAS THE CYCLE CHANGED?
NO
YES

• Prices will still go up prices will still go
  down
• Uncertainty remains over costs
• Good investment returns will fund price
  reductions and vice versa
• Profitable years swell next years capacity and
  vice versa
• Market share temptations will drive price
  reduction decisions
• Intense competition
• Competitive advantage

• Lower UW peaks and shallower troughs
• CY UW profits essential to reach target ROC
• PY claims releases will be smaller
• Reduced claims inflation
• Low investment returns
• Shareholders demand stable earnings
• Regulator prudential regulation
• Solvency II